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The real cost of money

| Posted by: Paul Donovan | Tags: Paul Donovan Weekly

  • It would be 'loco' for the US Federal Reserve not to raise rates. The US enjoys good growth and a strong labor market. The rise in interest rates has made cash and bonds real alternative assets for financial investors. Negative real rates had pushed savers into risk assets. Zero real fed funds and positive real bond yields change that.
  • A savers' real rate is the interest rate less consumer price inflation. People save now to buy later. The change in price of things between now (when they save) and later (when they spend) is important.
  • A borrower's real rate is different. The point of borrowing is to buy now, pay later. What happens to the price between now (when they buy) and later (when they pay) is not very interesting to the borrower. What worries the borrower is whether they can manage to repay the debt.
  • The real interest rate for a borrower is the interest rate less income growth. Income growth for households and companies is still far above the fed funds rate. Savers have a real alternative to risk assets today. But borrowing to spend or invest in the real economy is still really cheap.